The Bermuda Monetary Authority (the "Authority") has issued a guidance note effective January 1, 2025, the aim of which is to ensure stakeholders have a clear understanding of the regulatory regime for segregated accounts and separate account companies in Bermuda.
The guidance note outlines the Authority's expectations for companies carrying on general business insurance both in the limited purpose and commercial insurance classes that use segregated accounts under the Segregated Accounts Companies Act 2000 ("SAC Act") or separate accounts pursuant to a private act of the legislature (hereinafter a "Segregated Account") to conduct regulated insurance business with an aim of ensuring policyholders have an appropriate level of protection that is consistent with policyholders of insurers that do not conduct insurance business using a Segregated Account structure.
The guidance note does not apply to incorporated segregated accounts companies or incorporated segregated accounts insurers which are subject of a guidance note previously issued in December 2020. Further, the guidance note is subordinate to the guidance note for special purpose insurers that was issued by the Authority on July 1, 2020, which provides specific guidance on the structure, reporting and operation of special purpose insurers.
The Authority has adopted a risk-based, regulatory framework and a proportional approach given the risk profile and licence class of an insurer. While the Authority aims to provide clarity in its approach, it should be noted that the guidance note is not exhaustive. A duty remains with the board of directors (the "Directors") and management team of an insurer to ensure its ongoing compliance with the legislation and regulations and that any conditions of a company's licence are met.
Ownership and governance of accounts
An insurer conducting insurance business using Segregated Accounts1 must ensure that its Directors understand their responsibility to ensure that business, including business in each Segregated Account, is effectively directed and operated by the insurer's management team, insurance manager or any outsourced service providers and further, that all insurance business is conducted with integrity, due care and appropriate professional skills.
The Directors must ensure that management team has compliance processes in place that are suitable for assessing and documenting fitness and proprietary propriety of its members, controllers, officers, and the insurance manager and any other outsourced service providers. Further, the Directors are responsible for providing appropriate oversight of the insurer's governance and management framework, risk management and internal controls framework, including any activities and functions that are delegated or outsourced.
The Directors should show that there are robust proceedings and processes in place for suitable know-your-client information to be collected and retained, and that due diligence is performed on all persons participating in a Segregated Account as well as all persons providing capital or collateral. These processes must be subject to risk-based, ongoing monitoring. In the same vein, the Directors are required to ensure that there are processes and controls in place to facilitate compliance with Bermuda's anti-money laundering and anti-terrorist financing laws.
Licensing
Segregated Accounts companies that carry on insurance business must apply to be registered under the Insurance Act 1981 (the "Insurance Act"). The insurance licensing application must be comprehensive and should include all relevant documents related to the insurance business that will be conducted in the Segregated Accounts including draft or executed copies of any insurance contracts, collateral agreements, copies of agreements with account owners and the like. The application must also set out in detail the nature of the relationship between the account owner, policyholders and the company, the way capital will flow, the nature of funding that is available to the company, any arrangements that exist for topping up capital, and any arrangements that exist to ensure that the capital of each Segregated Account is segregated from the assets of the other Segregated Accounts and the general account. There must be included within the contracts language that deals with limited recourse between the Segregated Accounts (see below) and states that recovery in relation to liabilities of each Segregated Account is limited to the assets of a particular Segregated Account.
The guidance notes also provide certain criteria that will apply depending on the class of licence within which the general business insurer falls. For example, if the company intends to write insurance that would ordinarily meet the criteria to be registered as a class 1, 2 or 3 insurer as defined by the Insurance Act, the applicant will generally be registered as a limited purpose insurer. In the case of unrelated insurance business (as again as defined by the Insurance Act), the applicant would generally be registered as a commercial insurance class 3A, 3B or 4 insurer, and in this instance will be assessed at both the insurer and Segregated Account levels.
A company which plans to write a combination of related and unrelated insurance business will be registered in the highest applicable registration class.
Where an insurer only intends to conduct insurance using Segregated Accounts, the Authority will include a condition on the certificate of registration that requires its prior written approval if any insurance is to be conducted through the general account.
When the application for registration is made, the company will also need to disclose details related to ongoing funding arrangements related to the insurance business to be conducted using the Segregated Accounts and will have to substantiate the existence of the capital funding the exposure in the Segregated Accounts. Capital and the collateral requirements will be reviewed by the Authority as part of their review of the annual statutory filings that are required to be made by the company.
Risk Management
In accordance with the Insurance Code of Conduct, a company with Segregated Accounts must establish sound and effective governance and risk management proof frameworks that are proportionate to its risk profile.
The framework should facilitate the effective and efficient operations of the company and address the organizational structure of the Segregated Accounts including the delegation or outsourcing of management and operational tasks, the segregation of duties and any conflicts of interest that may be held by management. It should be noted that the governance and oversight responsibilities rest with the insurer's Directors and may not be delegated.
Any possible conflicts of interest between or reliance on the Directors and an account owner or participant should be mitigated as much as possible. The Directors are responsible for ensuring that controls are in place such that a company that uses Segregated Accounts and is registered under classes 1, 2, 3, CI or IIGB has insurance exposure in the Segregated Account but is not fully backed by contributed capital or collateral that forms of contingent capital or collateral can immediately be made available if necessary.
Reporting requirements
Statutory financial statements must include information that is calculated to fulfill or provide: (i) as much of an early warning as is possible to any person examining the insurer's statements of any financial or operational difficulties into which the insurer's business has fallen or is likely to fall including statements made by way of notice of the observance or non-observance by an insurer of any margin of solvency and (ii) a basis upon which the Authority or another regulatory agency may within a reasonable period of time take action under the Insurance Act or other legislation which will enable the Authority to safeguard any element of the public's interest involved in, or affected by, the insurer's business.
Information on each Segregated Account of a company that is writing insurance must be included in the statutory financial statements to help facilitate regulatory oversight. The Authority has now introduced a schedule of segregated accounts and separate accounts (the "Schedule") which will form part of the statutory filings. The contents of the Schedule are designed to provide sufficient information in the statutory financial statements to allow the Authority to assess the financial and operational status of an insurer's general account as well as each of the Segregated Accounts.
Going forward, the completed Schedule will form an integral part of an insurer's statutory financial statements. It will include the minimum information insurers should provide and any additional information necessary to fulfill the requirements of the Insurance Act relating to statutory financial statement disclosures.
The insurer's approved auditor must annually audit the company's statutory financial statements. The audit should include in its scope the Schedule as it now forms part of the statutory financial statements, and the Authority will expect auditors to perform sufficient audit procedures (within their materiality threshold) to confirm the existence and valuation of all assets and liabilities of a Segregated Account including any instruments that are presented as collateral that backs the insurance exposures in the Segregated Accounts. An auditor is required to give notice to the Authority if it becomes aware of any matter in relation to an insurer that is likely to be of material significance in the discharge of the Authority's functions under the Insurance Act.
Balance sheet accounting
This is a modified accounting presentation in which the assets related to one or more Segregated Accounts is reported on the balance sheet as a single line item and the liabilities and capital related to the Segregated Accounts are reported on the balance sheet as a single line item. Modification in the presentation of the statutory financial statements now requires approval under the Insurance Act in relation to both limited purpose insurers and commercial insurers. This will enable the Authority to consider whether the general account is exposed to risks in the Segregated Accounts and whether the insurance exposure in the Segregated Accounts is fully provided for by the account owners or participants.
Declarations of compliance
Insurers are required to file a declaration (the "Declaration") confirming compliance with certain matters as part of its statutory financial statements. The Declaration is required to include whether or not the insurer has achieved certain minimum criteria applicable to it with respect to the preceding financial year. These criteria include minimum margins of solvency, any enhanced capital requirements, any applicable conditions directions or restrictions that were imposed on or approvals granted to the insurer, or any minimum liquidity ratios for general business applicable to its financial year end. The Declaration applies to insurance in both the general account and each Segregated Account.
Loss reserve specialist opinion
The statutory financial return required to be filed by an insurer under the Insurance Act must include the opinion of the approved loss reserve specialist (LRO) regarding the insurer's loss and loss expense provisions. Previously, the Authority has approved exemptions from the requirement to file an opinion for general business for some insurers with Segregated Accounts. These exemptions have traditionally included Segregated Accounts that are fully collateralized to no policy limits or in circumstances where no insurance has been written or no exposure exists in the general account. In light order to ensure reserves are adequate and there is adequate capital to fund exposure, the Authority will require an opinion on the reserves in the general account in addition to reserves reported at the Segregated Account level.
The LRS is required to opine on the amounts reported in the balance sheet as well as the amount reported in the Schedule which will ensure that the LRS opines on the adequacy of all reserves. The Authority is reconsidering the frequency with which it will approve waivers of opinions from the LRS. Applications will be considered on a case-by-case basis and the Authority may require evidence or an actuarial review of the gross reserves as well as the details of the insurance program and the capital used to fund the exposure in the event the reinsurer does not perform in support of the application.
Restrictions to return of capital
The Authority will consider capital distribution applications under the Insurance Act from insurers operating Segregated Accounts. Capital distribution applications may be pre-approved in certain circumstances Including where the insurance contract is fully collateralized to the policy limits and has, by mutual consent of the insurer and reinsurer, agreed to release capital or collateral that automatically reduces the limits under the policy.
The Authority may provide approval for a fixed period (usually one year) subject to a condition requiring they be provided with details of the capital return within 30 days of completion of said return. This will allow insurers to carry out the return of capital or collateral in respect of Segregated Accounts specified in their insurance agreements or contractual obligations with minimal delay in cases where they adhere strictly to agreed upon terms.
Insurers intending to reduce the total statutory capital by more than 15% in a financial year will be required to obtain approval from the Authority. Should an insurer have any specific conditions attached to their registration restricting dividends, distributions, and/or returns of capital, they will also be required to adhere to these specific conditions.
Collateral quality, impairment and disclosures
The Directors must ensure effective oversight of the insurer's management and operational policies, procedures and controls for the collateral and funding available based on the exposure that is assumed by the Segregated Accounts with reference to contributed capital and contingent forms of capital, and in line with any representation set out in the company's approved business plan, licensing conditions, and any relevant contractual arrangements.
The guidance note lists certain arrangements which the Authority is not expected to perceive as an acceptable means of funding insurance exposure written in Segregated Accounts. These include:
- insurance exposure that is collateralized using speculative and low quality investment instruments;
- exposure that is collateralized using receivables including premium receivables except any net premiums receivable from the cedant provided the insurance or reinsurance contract has appropriate contractual provisions that permit the insurer to offset the losses payable by them against the net premiums under the insurance or reinsurance contract. In such a case, net premiums shall be the gross premium written, less any applicable expenses such as brokerage or tax; and
- contractual arrangements that use the limited recourse language instead of actual collateral or capital.
Documentation relating to a Segregated Account is expected to disclose details such as the types, issuers, collateral structure and requirements, investment guidelines and expectations for credit ratings for collateral where appropriate. The Authority expects that the Segregated Accounts will generally carry minimal investment and counterparty risk credit risk with respect to collateral.
Other protections include certain circumstances where the Segregated Account is writing fully collateralized insurance business. In such an instance, the collateral must be contributed to the Segregated Account on or before the effective date of the insurance contract.
Evergreen and irrevocable letters of credit may be acceptable forms of contingent capital in certain circumstances. The guidance notes set out the criteria that need to be met.
The Directors, through their oversight of the insurer's management, or the insurance manager is responsible for ensuring the validity and continued existence of the letters of credit during the period of the insurance contracts written in Segregated Accounts or the general account are at risk. Any letter of credit must first be approved by the Authority before it was reported. The insurer is also required to notify the Authority through the principal representative if it reaches the view or becomes aware that an impairment of the assets backing the collateral has occurred and that the insurer is liable to top up the collateral in accordance with each insurance contract. The principal representative must furnish the Authority with a report in writing outlining all the relevant particulars including how the top has been or shall be satisfied.
Limited recourse
Insurers should ensure that there are clear contractual arrangements to govern the operations of each Segregated Account.
Where limited recourse provisions apply, limited recourse provisions allow contracts to be commuted or cancelled when there is a liability to the third party that exceeds the value of the available assets. Where limited recourse provisions apply and Segregated Account is insolvent, the Segregated Account may be liquidated and closed as a measure of last resort by an independent party to the contract. Limited recourse language may not be used to justify that the insurance business is fully funded.
Instead, limited recourse language is a backstop where there is a shortage of assets available to fund exposure and that that has been written and the insurer or the cell is deemed to be no longer operating on a going concern basis.
Further, the Authority makes it clear that including limited recourse language in a contract is not a substitute for the need to have clear and effective contractual language within the insurance policy or agreement specifying the limits and the aggregate limits, the required capital and collateral structure and operations, a prudent treasury or investment strategy, and adequate governance, operational and risk management controls.
Material changes in the business
The following changes are considered to be material for purposes of determining whether the Authority needs to be notified of, and approve, the change prior to taking effect:
- the provision of insurance for any additional risks that were not contemplated in the initial transaction and/or business plan;
- material changes to the insurance contract or any of the collateral or ancillary contracts to the insurance contract;
- modifications to the material disclosures included in the original application;
- raising additional capital from investors and/or Segregated Account participants not identified or contemplated in the original documentation provided to the Authority;
- any other changes that are pertinent to the business of the company where the changes would be deemed by a reasonable and knowledgeable person to be material; and
- any material changes as outlined in the Insurance Act.
A series of minor changes when taken as a whole may constitute a material change that needs notification.
The approval process for any material change in an insurer that operates Segregated Accounts will take into account the nature, scale and complexity of those changes as determined by the Authority to ensure the risks are effectively mitigated and the capital is appropriate to support the ongoing operations of the insurer. The Authority will consider whether the changes constitute a change in the insurer's business plan and, to the extent that it does, may request additional information in order to assess the impact the changes will have on the insurer and the relevant Segregated Accounts.
Conclusion
In light of recent developments in the market, the Authority seeks to ensure that relevant stakeholders have a sound understanding of the regulatory regime for segregated and separate account companies in Bermuda. The aim of the guidance note is to provide greater consistency in reporting, licensing, authorizations and prudential supervision and will provide the Authority with a more comprehensive view of insurance business in Bermuda. When it becomes effective in January 2025, the provisions of the guidance note will apply to the financial years of a company commencing on or after that date and there is a transition period during which companies will be required to comply with the proposed changes and give due consideration to any applications of a transitional nature in the first year following implementation of the guidance note.
Footnote
1. The guidance note appears to refer to companies that are registered under the SAC Act only.
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